What Is A Non-Fungible Token (NFT)

Definition

NFTs (or “non-fungible tokens”) are a special kind of cryptoasset in which each token is unique — as opposed to “fungible” assets like Bitcoin and dollar bills, which are all worth exactly the same amount. Because every NFT is unique, they can be used to authenticate ownership of digital assets like artworks, recordings, and virtual real estate or pets.

Non-fungible tokens (NFTs) seem to have exploded out of the ether this year. From art and music to tacos and toilet paper, these digital assets are selling like 17th-century exotic Dutch tulips—some for millions of dollars.

But are NFTs worth the money—or the hype? Some experts say they’re a bubble poised to pop, like the dotcom craze or Beanie Babies. Others believe NFTs are here to stay, and that they will change investing forever.

 

 

What Is an NFT?
An NFT is a digital asset that represents real-world objects like art, music, in-game items and videos. They are bought and sold online, frequently with cryptocurrency, and they are generally encoded with the same underlying software as many cryptos.

Although they’ve been around since 2014, NFTs are gaining notoriety now because they are becoming an increasingly popular way to buy and sell digital artwork. A staggering $174 million has been spent on NFTs since November 2017.

NFTs are also generally one of a kind, or at least one of a very limited run, and have unique identifying codes. “Essentially, NFTs create digital scarcity,” says Arry Yu, chair of the Washington Technology Industry Association Cascadia Blockchain Council and managing director of Yellow Umbrella Ventures.

This stands in stark contrast to most digital creations, which are almost always infinite in supply. Hypothetically, cutting off the supply should raise the value of a given asset, assuming it’s in demand.

But many NFTs, at least in these early days, have been digital creations that already exist in some form elsewhere, like iconic video clips from NBA games or securitized versions of digital art that’s already floating around on Instagram.

For instance, famous digital artist Mike Winklemann, better known as “Beeple” crafted a composite of 5,000 daily drawings to create perhaps the most famous NFT of the moment, “EVERYDAYS: The First 5000 Days,” which sold at Christie’s for a record-breaking $69.3 million.

Anyone can view the individual images—or even the entire collage of images online for free. So why are people willing to spend millions on something they could easily screenshot or download?

Because an NFT allows the buyer to own the original item. Not only that, it contains built-in authentication, which serves as proof of ownership. Collectors value those “digital bragging rights” almost more than the item itself.

How Is an NFT Different from Cryptocurrency?
NFT stands for non-fungible token. It’s generally built using the same kind of programming as cryptocurrency, like Bitcoin or Ethereum, but that’s where the similarity ends.

Physical money and cryptocurrencies are “fungible,” meaning they can be traded or exchanged for one another. They’re also equal in value—one dollar is always worth another dollar; one Bitcoin is always equal to another Bitcoin. Crypto’s fungibility makes it a trusted means of conducting transactions on the blockchain.

NFTs are different. Each has a digital signature that makes it impossible for NFTs to be exchanged for or equal to one another (hence, non-fungible). One NBA Top Shot clip, for example, is not equal to EVERYDAYS simply because they’re both NFTs. (One NBA Top Shot clip isn’t even necessarily equal to another NBA Top Shot clip, for that matter.)

Beyond the high prices, there was one other fact that observers found fascinating. In exchange for their money, collectors who buy Beeples don’t receive any physical manifestation of the artwork. Not even a framed print. What they do get is an increasingly popular kind of cryptoasset called an NFT — short for non-fungible token.

Each Beeple piece is paired with a unique NFT — a token attesting that each owner’s version is the real one. “We are in a very unknown territory,” Christie’s contemporary art specialist Noah Davis told Reuters. “In the first 10 minutes of bidding we had more than a hundred bids from 21 bidders and we were at a million dollars.”

What does “non-fungible” mean?
Every bitcoin is worth as much as every other bitcoin. NFTs, on the other hand, are all unique. “Fungibility” refers to goods or assets that are all the same and can be swapped interchangeably. A dollar bill is another perfect example — each is worth exactly one dollar.

Concert tickets, by contrast, are non-fungible. Even if every Radiohead ticket is the same price, they aren’t directly exchangeable. Each represents a specific seat and a specific date — no other ticket will have those exact characteristics.

How Does an NFT Work?
NFTs exist on a blockchain, which is a distributed public ledger that records transactions. You’re probably most familiar with blockchain as the underlying process that makes cryptocurrencies possible.

Specifically, NFTs are typically held on the Ethereum blockchain, although other blockchains support them as well.

An NFT is created, or “minted” from digital objects that represent both tangible and intangible items, including:

  • Art
  • GIFs
  • Videos and sports highlights
  • Collectibles
  • Virtual avatars and video game skins
  • Designer sneakers
  • Music

Even tweets count. Twitter co-founder Jack Dorsey sold his first ever tweet as an NFT for more than $2.9 million.

Why are NFTs important?
You can think of NFTs as being kind of like certificates of authenticity for digital artifacts. They’re currently being used to sell a huge range of virtual collectibles, including:

  • NBA virtual trading cards
  • Music and video clips from EDM stars like Deadmau5
  • Video art by Grimes
  • The original “nyan cat” meme
  • A tweet by Dallas Mavericks owner and entrepreneur Mark Cuban
  • Virtual real estate in a place called Decentraland

As as Bitcoin and other crypto has boomed in popularity over the last year, NFTs have also soared — growing to an estimated $338 million in 2020. Each NFT is stored on an open blockchain (often Ethereum’s) and anyone interested can track them as they’re created, sold, and resold. Because they use smart contract technology, NFTs can be set up so that the original artist continues to earn a percentage of all subsequent sales.

Along the way, NFTs have raised fascinating philosophical questions about the nature of ownership. Wondering why digital artifacts that can be endlessly copied and pasted have any value at all? Proponents would point out that most kinds of collecting isn’t based on inherent value. Old comic books were produced for pennies’ worth of ink and paper. Rare sneakers are often made out of the same materials as worthless ones. Some paintings hang in the Louvre, others end up in thrift shops.

As the collector who sold the $6.6 million Beeple piece noted, you can take a nice picture of the Mona Lisa, but it’s not the Mona Lisa. “It doesn’t have any value because it doesn’t have the provenance or the history of the work,” said the Beeple fan. “The reality here is that this is very, very valuable because of who is behind it.”

 

Essentially, NFTs are like physical collector’s items, only digital. So instead of getting an actual oil painting to hang on the wall, the buyer gets a digital file instead.

They also get exclusive ownership rights. That’s right: NFTs can have only one owner at a time. NFTs’ unique data makes it easy to verify their ownership and transfer tokens between owners. The owner or creator can also store specific information inside them. For instance, artists can sign their artwork by including their signature in an NFT’s metadata.

What Are NFTs Used For?
Blockchain technology and NFTs afford artists and content creators a unique opportunity to monetize their wares. For example, artists no longer have to rely on galleries or auction houses to sell their art. Instead, the artist can sell it directly to the consumer as an NFT, which also lets them keep more of the profits. In addition, artists can program in royalties so they’ll receive a percentage of sales whenever their art is sold to a new owner. This is an attractive feature as artists generally do not receive future proceeds after their art is first sold.

Art isn’t the only way to make money with NFTs. Brands like Charmin and Taco Bell have auctioned off themed NFT art to raise funds for charity. Charmin dubbed its offering “NFTP” (non-fungible toilet paper), and Taco Bell’s NFT art sold out in minutes, with the highest bids coming in at 1.5 wrapped ether (WETH)—equal to $3,723.83 at time of writing.

Nyan Cat, a 2011-era GIF of a cat with a pop-tart body, sold for nearly $600,000 in February. And NBA Top Shot generated more than $500 million in sales as of late March. A single LeBron James highlight NFT fetched more than $200,000.

Even celebrities like Snoop Dogg and Lindsay Lohan are jumping on the NFT bandwagon, releasing unique memories, artwork and moments as securitized NFTs.

How to Buy NFTs
If you’re keen to start your own NFT collection, you’ll need to acquire some key items:

First, you’ll need to get a digital wallet that allows you to store NFTs and cryptocurrencies. You’ll likely need to purchase some cryptocurrency, like Ether, depending on what currencies your NFT provider accepts. You can buy crypto using a credit card on platforms like Coinbase, Kraken, eToro and even PayPal and Robinhood now. You’ll then be able to move it from the exchange to your wallet of choice.

You’ll want to keep fees in mind as you research options. Most exchanges charge at least a percentage of your transaction when you buy crypto.

Popular NFT Marketplaces
Once you’ve got your wallet set up and funded, there’s no shortage of NFT sites to shop. Currently, the largest NFT marketplaces are:

• OpenSea.io: This peer-to-peer platform bills itself a purveyor of “rare digital items and collectibles.” To get started, all you need to do is create an account to browse NFT collections. You can also sort pieces by sales volume to discover new artists.

• Rarible: Similar to OpenSea, Rarible is a democratic, open marketplace that allows artists and creators to issue and sell NFTs. RARI tokens issued on the platform enable holders to weigh in on features like fees and community rules.

• Foundation: Here, artists must receive “upvotes” or an invitation from fellow creators to post their art. The community’s exclusivity and cost of entry—artists must also purchase “gas” to mint NFTs—means it may boast higher-caliber artwork. For instance, Nyan Cat creator Chris Torres sold the NFT on the Foundation platform. It may also mean higher prices — not necessarily a bad thing for artists and collectors seeking to capitalize, assuming the demand for NFTs remains at current levels, or even increases over time.

Although these platforms and others are host to thousands of NFT creators and collectors, be sure you do your research carefully before buying. Some artists have fallen victim to impersonators who have listed and sold their work without their permission.

In addition, the verification processes for creators and NFT listings aren’t consistent across platforms — some are more stringent than others. OpenSea and Rarible, for example, do not require owner verification for NFT listings. Buyer protections appear to be sparse at best, so when shopping for NFTs, it may be best to keep the old adage “caveat emptor” (let the buyer beware) in mind.

Where do you buy or sell NFTs?
Digital-artwork NFTs are mostly sold on specialized marketplaces like Zora, Rarible, and Opensea. Coinbase NFT, a peer-to-peer marketplace that will make minting, purchasing, showcasing, and discovering NFTs easier than ever, is coming soon (sign up for the waitlist). If you’re more interested in games and sports collectibles, developers like Dapper Labs have created experiences including NBA Top Shot (virtual trading cards) and Cryptokitties (a Pokemon-ish digital-cat collecting app that actually was the first NFT hit in late-2017). Online games including Gods Unchained are starting to use NFTs to sell in-game assets like weapons or cosmetic upgrades. Real estate in new virtual worlds is sold via markets including Decentraland and The Sandbox.

You can also buy or sell some NFTs directly via a compatible crypto wallet.

Should You Buy NFTs?
Just because you can buy NFTs, does that mean you should? It depends, Yu says.

“NFTs are risky because their future is uncertain, and we don’t yet have a lot of history to judge their performance,” she notes. “Since NFTs are so new, it may be worth investing small amounts to try it out for now.”

In other words, investing in NFTs is a largely personal decision. If you have money to spare, it may be worth considering, especially if a piece holds meaning for you.

But keep in mind, an NFT’s value is based entirely on what someone else is willing to pay for it. Therefore, demand will drive the price rather than fundamental, technical or economic indicators, which typically influence stock prices and at least generally form the basis for investor demand.

All this means, an NFT may resale for less than you paid for it. Or you may not be able to resell it at all if no one wants it.

NFTs are also subject to capital gains taxes—just like when you sell stocks at a profit. Since they’re considered collectibles, however, they may not receive the preferential long-term capital gains rates stocks do and may even be taxed at a higher collectibles tax rate, though the IRS has not yet ruled what NFTs are considered for tax purposes. Bear in mind, the cryptocurrencies used to purchase the NFT may also be taxed if they’ve increased in value since you bought them, meaning you may want to check in with a tax professional when considering adding NFTs to your portfolio.

That said, approach NFTs just like you would any investment: Do your research, understand the risks—including that you might lose all of your investing dollars—and if you decide to take the plunge, proceed with a healthy dose of caution.

How do NFTs work?
If you’re interested in DeFi, you might have heard of the ERC-20 standard, which allows anyone to create a token compatible with the Ethereum blockchain. Those are “fungible” tokens. Most non-fungible tokens are built using the ERC-721 and ERC-1155 standards, which allow creators to issue unique cryptoassets via smart contract. Because each NFT is stored on a blockchain, there is an immutable record starting with the token’s creation and including every sale. (Some NFT-focused developers have also built their own alternative blockchains, including Dapper Lab’s Flow.)

What can you do with NFTs once you buy them?
Good question! Some people display their digital artworks on large monitors. Some buy virtual real estate (via NFT, of course) in which they’re able to build virtual galleries or museums. You can also roam virtual worlds like Decentraland and check out other people’s collections. For some fans, the appeal is in the buying and selling — much like any other asset class. (The collector who sold the $6.9 million Beeple paid less than $70,000 for it in October 2020).

More and more mainstream artists have also gotten involved in the space — especially from the world of music. In early March, Nashville band Kings of Leon announced their next album would arrive in the form of multiple NFTs. Depending on which a fan buys, various perks will be unlocked — like alternate cover art, limited-edition vinyl, and even a “golden ticket” to a VIP concert experience.


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